Credit Counseling Organizations By Debra Cowen and Debra Kawecki Overview Introduction Credit counseling organizations provide valuable services to the public. They educate consumers about better money management techniques, promote debt reduction strategies, and help their clients avoid bankruptcy and its financial consequences. However, some credit counseling organizations prey on the vulnerability of the clients they are supposed to be helping. The purpose of this article is to raise awareness that there is a potential for abuse by credit counseling organizations that have received or are requesting classification as organizations described in IRC 501(c)(3). In this article Part I of this article discusses the Credit Repair Organizations Act, the federal government's response to abuses in the credit repair industry. When considering applications from credit counseling organizations, it is important to keep in mind that in general the Credit Repair Organizations Act does not apply to IRC 501(c)(3) organizations. The federal statutory scheme relies on the determination by the Service that an organization qualifies for tax-exempt status. Part II of this article discusses two states’ efforts to protect consumers from financial fraud. The states' regulatory schemes do not apply to IRC 501(c)(3) organizations. The states are also relying on the determination by the Service that an organization qualifies for tax-exempt status. Part III discusses the Model Codes adopted by two voluntary credit counseling certification organizations. These Codes provide a model for exempt credit counseling organizations. Part IV discusses qualification of credit counseling organizations under IRC 501(c)(3) and IRC 501(c)(4). It examines revenue rulings and court cases. Continued on next page Credit Counseling Organizations – CPE 2004-1, page 1 Overview, Continued In this article, Part V discusses the type of development recommended when considering an continued application for exemption from a credit counseling or credit servicing agency. Part VI is the Conclusion Part VII is the Addendum. The Addendum contains a copy of the Credit Repair Organizations Act and samples of consumer alerts from state attorneys general and the Federal Trade Commission. This information is helpful when considering the distinction between legitimate credit counseling agencies and illegal credit repair services. Table of This article contains the following topics: contents Topic See Page Overview 1 Part I: Federal Efforts Protecting Consumers Against Financial 3 Fraud S The Credit Repair Organizations Act 5 S The Federal Trade Commission Act 8 Part II: State Efforts in Protecting Consumers Against Financial 9 Fraud Part III: Voluntary Credit Counseling Agency Certification 12 Part IV: Qualification for Exemption under IRC 501(c)(3) 16 Part V: Exemption Applications Case Development 21 Part VI: Conclusion 24 Part VII: Addendum S The Credit Repair Organizations Act 25 S Consumer Alerts 34 Credit Counseling Organizations – CPE 2004-1, page 2 Part I: Federal Efforts in Protecting Consumers Against Financial Fraud Introduction The Service developed its position on credit counseling agencies in the 1960s. If an agency primarily provided information, exemption under IRC 501(c)(3) was considered appropriate. The need to review this subject stems from recent concern that certain organizations, describing themselves as educational credit counseling agencies, may be engaged in activities that are not described in IRC 501(c)(3). This article discusses both credit counseling agencies and credit repair organizations. S A credit counseling agency educates the consumer as its principal activity. It may also assist the consumer in consolidating debt and negotiate between debtors and creditors to lower interest rates and waive late and over-limit fees. S Credit repair involves claims that the agency can restore credit in a short period of time. Certain credit repair practices are illegal. The states' attorneys general warn that restoring credit is a lengthy procedure, and claims to do it quickly may involve identity theft and other illegal practices. The federal statutory scheme and that of many states and private certifying organizations rely on the Service's determination that an organization is exempt under IRC 501(c)(3). If an organization can demonstrate that it is exempt under IRC 501(c)(3), it usually avoids all regulatory requirements. Because the Service's determination of exemption is central to both federal and state regulatory enforcement programs, the determination specialist must examine applications for exemption with a heightened awareness. The following discussion and the development questions are designed to review the published guidance in light of changes in the field of credit counseling and credit repair. Credit Counseling Organizations – CPE 2004-1, page 3 Part I: Federal Efforts in Protecting Consumers Against Financial Fraud, Continued Federal The Federal Trade Commission enforces at least two statutes that apply to Legislation the activities of credit counseling and credit repair organizations. S The Credit Repair Organizations Act became effective on April 1, 1997, and is directed to the credit repair industry. S The FTC Act, a statute of more general application, applies to the operations of both credit repair organizations and credit counseling organizations. Bankruptcy reform legislation was proposed in 2002 and remains a concern of Congress. Under the proposals that were considered, the role of credit counseling organizations in the bankruptcy process would be significantly enhanced. S The proposed legislation provided that an individual may not file a petition for bankruptcy under Chapter 11 of the Bankruptcy Code unless he has sought assistance from an approved nonprofit budget and credit counseling agency. The United States trustee or bankruptcy administrator in each judicial district would be required to compile a list of approved credit counseling agencies. S In the event similar legislation passes, there is likely to be an influx of new nonprofit credit counseling organizations setting up business across the country and seeking exemption under IRC 501(c)(3). Credit Counseling Organizations – CPE 2004-1, page 4 Part I: Federal Efforts in Protecting Consumers Against Financial Fraud - The Credit Repair Organizations Act Introduction Congress has taken steps to protect citizens against the worst of the credit repair scams in the Credit Repair Organizations Act, [15 U.S.C. §§ 1679 et seq.] The Act seeks to ensure that prospective buyers of credit repair services are provided with the information necessary to make an informed decision, and to protect the public from unfair or deceptive advertising and business practices by credit repair organizations. Definition of a The Act defines a credit repair organization as: Credit Repair Organization any person who uses any instrumentality of interstate commerce or the mails to sell, provide, or perform (or represent that they will sell, provide, or perform) any service, in return for the payment of money or other valuable consideration, for the express or implied purpose of - (i) improving any consumer's credit record, credit history, or credit rating; or (ii) providing advice or assistance to any consumer with regard to any activity or service in clause (i). The Act excludes from the definition of a credit repair organization: S any nonprofit organization which is exempt from taxation under IRC 501(c)(3). This strong federal expression of consumer protection can be defeated by an erroneous determination that an organization is exempt under IRC 501(c)(3). It is crucial, therefore, that the Service make every effort to adequately develop all the facts and circumstances regarding an applicant's operations. Continued on next page Credit Counseling Organizations – CPE 2004-1, page 5 Part I: Federal Efforts in Protecting Consumers Against Financial Fraud - The Credit Repair Organizations Act, Continued Full disclosure The Act requires full disclosure regarding consumer rights before any contract for credit repair services is executed. A written statement must be provided and signed by all prospective customers, and must be retained by the credit repair organization for at least two years after the statement is signed. Consumers must be advised: S They may dispute inaccurate information in their credit report by contacting the credit bureau directly. S There is no right to have accurate, current, and verifiable information removed from a credit report unless it is over seven years old. Bankruptcy information can be reported for ten years. S They have a right to sue a credit repair organization that violates the Credit Repair Organizations Act. S They have the right to cancel a contract with any credit repair organization for any reason within three business days from the date it was signed. Written A written contract is also required and must: Contract 1. specify the terms and conditions of payment, including the total amount of all payments to the credit repair organization or any other person 2. contain a full and detailed description of the services to be performed by the credit repair organization for the consumer, including: (A) all guarantees of performance; and (B) an estimate of the time required for the performance of the services 3. contain the credit repair organization's name and principal business address Continued on next page Credit Counseling Organizations – CPE 2004-1, page 6 Part I: Federal Efforts